What’s wrong with 6% GDP growth?

Five years (2003-08) of near-9% growth suddenly seems a distant memory.

The CSO estimated GDP growth in October-December 2008 at just 5.3%. Indeed, the IMF estimates that India will average just 5.1% growth in the calendar year 2009. There is much gloom and doom in the stock market, which has now fallen below its October-November lows. The government claims bravely that its stimulus packages are finally having an impact, but this is not reflected in the mood of corporates or households.

Maybe growth in 2009 will be 6%, a tad higher than the IMF estimate. But it may not get much faster till the world economy recovers, and that may not happen till 2010 or even 2011. If so, India will grow at just 6% annually for the next two years.

Some experts ask, what’s wrong with 6% growth? Why are we whining and groaning? After all, 6% growth will represent the fastest growth rate in the world after China’s. If India can grow at 6% when the US has just plunged downward by 6%, why not enjoy the spectacle? One consulting firm says that it scents trouble in only one of six verticals of its business. Why then is so much gloom and doom?

I personally believe that gloom is fully justified in the short run, but not a sense of doom. When a country moves up from 4% growth to 6%, this generates optimism and excited enthusiasm. But if growth falls from 9% to 6%, that is terribly painful. What matters is not just the rate of growth but its direction too.

The mood of corporates, governments and households depends a lot on expectations. Keynes emphasized the critical role played by the animal spirits of entrepreneurs, who take risks, innovate and so accelerate growth. When the economy swings up, animal spirits bubble fiercely. But in a downswing, animal spirits droop. Risk taking is replaced by risk aversion, adventure by caution, and innovation by safety-first tactics.

During the upswing of 2003-08, entrepreneurs were able to raise ever larger sums of equity at ever higher prices. They were also able to get ever larger loans at diminishing rates of interest, especially foreign currency loans. This explosive growth of cheap financing drove India’s 9% boom. Some economists argue that India’s own savings rate has shot up to 37%, and this is the main driver of growth. Not so. The sudden rise in India’s savings rate is cyclical in substantial measure, and will now swing down as corporate and government savings collapse. The earlier cyclical upswing was itself predicated on corporate access to cheap, plentiful capital.

Today that access has become difficult and expensive. Leveraged takeovers—Tata Steel’s purchase of Corus, Tata Motors’ acquisition of Jaguar Land Rover, Hindalco’s purchase of Novellis—were once hailed as immense national triumphs. Today they look over-leveraged and overpriced disasters. Corporates with dollar loans now have to mark these to market, suffering huge losses.

The plight of small and medium enterprises is grim. They face huge delays in payments from customers, while their own credit lines have closed. Even if GDP grows by 6%, industry may grow at less than 3% per year. So, 6% growth should legitimately translate into corporate and investor gloom.

Central and state governments are equally hit by the decline in growth. Revenue from corporate and income tax has been growing at a breakneck annual rate of 30-40% for some years, financing a spending spree. This high spending pattern has now been buttressed by additional spending and tax cuts in three stimulus packages. In consequence, the government’s fiscal position, which had been improving dramatically in the era of 9% growth, is now in shambles.

The earlier revenue boom facilitated enormous increases in outlays on Bharat Nirman, Sarva Shiskha Abhiyan, and the National Rural Employment Guarantee Scheme. But now that GDP growth has suddenly slowed to 5-6%, the government finds its coffers emptying fast, and so its borrowing requirement has tripled over budget estimates to Rs 330,000 crore. This threatens to soak up all bank funds, curbing corporate access to badly-needed capital and thus worsening the slump. So, the second-highest growth rate in the world, 6%, is consistent with huge fiscal strain and the crowding out of corporate borrowing. Good grounds for gloom, surely. It could be worse, of course—ask Pakistan —but it is bad enough.

Finally, consider the plight of households. They have been hit terribly by a negative wealth effect. When the economy was booming, owners of shares and real estate found their assets doubling and quadrupling, and happily spent part of this wealth increase on booming consumption. But now asset values have crashed, leaving consumers feeling suddenly impoverished. The associated pain is crimping spending.

In rural India, households are still doing well, thanks to good harvests and high minimum support prices, expanded employment guarantee programmes, and rising minimum wages in many states. This is the one silver lining in the economy. Yet credit to households has undoubtedly been squeezed hard. Housing and auto loans have fallen off sharply, and all the RBI’s attempts to lower consumer lending rates have had very limited impact so far. Consumer defaults (in personal loans, credit card debt, auto and housing loans) are galloping upwards. And the farm loan waiver may well induce galloping default in new farm loans too. So, despite the silver lining of rural consumption, this lights up only the fringes of a dark cloud.

Let’s return to the question posed in the title of this article: what’s wron